Breakdown? Nevermind

By

Michael Kahn

Updated May 18, 2005 11:59 p.m. ET

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IN LAST WEEK'S Getting Technical, we examined how the market had hit levels of resistance, where bears tend to flood it with supply and thereby halt price advances (see Getting Technical, "The Market Hits Resistance," May 11, 2005).

Sure enough, the following few days were weak as prices backed down a bit, but resistance does not necessarily suggest a change in trend. All it implies is that prices should stop rising.

Yet all the major indexes began to rally on Monday morning and that put, for most of them, a second higher low in place. In other words, the bears could not drive the market further in their desired direction, which puts price action in the bullish camp for the time being.

But like most chart analysts, we have to look beyond the daily net changes to see not what the market did, but how it did it. When we examine trading volume, we see that there is more activity when the market goes down than when it goes up, and that is still true today.

On the charts, the Standard & Poor's 500 has moved above the 1179 level that provided resistance last week (see Chart 1). It also has broken through the trend line drawn from the March peak, a sign that the tide may have turned for the better.

CHART 1

Technology stocks have perked up over the past two weeks and the Nasdaq Composite index also has moved above its declining trend line, this one drawn from its December peak (see Chart 2). Clearly, this sector has been the place to be this month (see Getting Technical, "Time For Tech?" May 9).

CHART 2

Still, the lack of public participation in the move -- as shown by the absence of heavy or at least increased volume -- is a warning. Without mass acceptance, rallies can't last.

Declining volume alone does not give a sell signal, but it does make the market a riskier place.

Jason Goepfert, technical analyst and president of SentimenTrader.com, views this lack of volume differently. He says, "The fact that volume has been decreasing while the market rallies is not worrisome to me."

"Low volume is commonly interpreted to mean a lack of interest from institutional traders," he continues. "But that is not the case: Even while volume in the Nasdaq has been fairly low lately, block trading volume (trades of at least 10,000 shares) has been averaging about 19% of total volume. That is not only higher than its two-year average; it is also higher than what we saw during the decline in April."

So, what does all this really mean for investors? It sure feels good to get several days in a row of strong gains. It is comforting that technology has awakened to lead the market while inflation hedges like gold and basic materials stocks fall behind. And everybody likes to see tumbling energy prices. So, is it time to buy? Well, yes and no.

Yes, enjoy the technology-induced rally. Perhaps the Nasdaq will hold above its now-broken resistance at 2022 and head towards the next barrier near 2100. Perhaps the S&P small cap 600 index will complete and break its inverted head-and-shoulders pattern to signal a real bottom and start a new leg up (see Chart 3).

CHART 3

Perhaps the New York Stock Exchange Composite index has failed to complete a regular head-and-shoulders topping pattern, best seen on weekly charts, to signal the failure of the bears to take over in the long term (see Chart 4).

CHART 4

Those are a lot of "perhaps," but admittedly it is very difficult to be bearish when the market refuses to go down. As we mentioned last week, the ingredients were in place for the resumption of the bearish trend, but the market had not yet mixed them all together to complete the recipe.

With today's surge in price and modest increase in volume, the market has told us that it still isn't quite ready to go down.

In fact, there is precedent for strength in the market and in the Nasdaq in particular. Technical analyst and portfolio manager David Steckler of LPL Financial points out that the current options expiration week has a history of an upward bias.

Steckler also says that late May to early June tends to be a bullish period, so there's a seasonal aspect to the market's strength in addition to positive news about oil inventories and corporate earnings. The bigger seasonal tendency in which the summer months are unkind to stocks is just getting under way, however.

Volume seems to agree, as the two days of really heavy volume this year, March 18 and April 15, both occurred as prices were either pausing in a declining trend or falling outright, and that still tells us the overall impetus is with the bears.

It is also painfully true that the market has toyed with the bears this month and that performance for the rest of this month will either vindicate them or force them to take their lumps.

As always, it is crucial to separate short-term from long-term trends, and match them appropriately to your own investment goals.

Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn writes the daily "Quick Takes Pro" newsletter (you can get a free trial at www.midnighttrader.com). He is the author of two books on technical analysis, most recently Technical Analysis: Plain and Simple, and was Chief Technical Analyst for BridgeNews. He also is on the Board of Directors of the Market Technicians Association (www.mta.org).

Breakdown? Nevermind

IN LAST WEEK'S Getting Technical, we examined how the market had hit levels of resistance, where bears tend to flood it with supply and thereby halt price advances (see Getting Technical, &quot;The Market Hits Resistance,&quot; May 11, 2005).

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